The Spillover Effect of SEC Comment Letters through Audit Firms: Evidence from Subjective Accounting Areas

Abstract

This study examines the spillover effect of SEC comment letters on an auditor’s other clientele. We focus our examination on goodwill, a frequent comment letter topic that garners significant auditor attention. We find that when companies receive an SEC comment letter with goodwill-related comments, their auditors are more likely to increase their scrutiny of this audit area among their other clientele in the same office as evidenced by an increased likelihood of recording impairment charges among their clients that exhibit goodwill impairment risk. Cross sectional analyses suggest that the spillover effect is more pronounced when the comment letter recipient subsequently recognized a goodwill impairment. We observe a similar spillover effect among an auditor’s clientele in the same industry and with changes to companies’ goodwill footnote disclosures. We corroborate these findings using another frequent comment letter topic – revenue recognition – and the likelihood of revenue-recognition related changes in accounting estimates.